China and India: Prospects for Recovery

The Chinese use two brush strokes to write the word 'crisis.'
One brush stroke stands for danger; the other for opportunity. In a
crisis, be aware of
the danger - but recognize the opportunity.

-John F. Kennedy

The BRIC nations (Brazil, Russia, India and China) are some
of the largest emerging market economies and many are hoping that
this group will lead the global economy out of the worst growth
slowdown in seventy years. Russia has had a tumultuous few months.
The economy and the currency have tumbled as falling oil prices,
outflows of foreign investment, dramatic economic contraction in
Central and Eastern Europe and growing concerns about Russian
aggression have taken their toll. Brazil's situation is not quite
as dramatic, but both the currency and the economy have been
impacted by the global slowdown and falling commodity prices, and
the economy looks set to contract in 2009. The central bank cut
rates by a record amount last week in an effort to boost the
economy.

There is more optimism about the economic prospects for India and
China, partly from a belief that Asia is the region best positioned
for a recovery and that a rising tide will lift the economic
prospects of the entire region. In addition, both countries have
significant consumer sectors and are consequently not completely at
the mercy of their export sectors, as is the case with Taiwan and
other regional economies. While I agree those reasons are valid for
both countries, they are unlikely to recover at the same time or
pace. That should result in varying equity and currency
performance.

China: Mixed signals, but better days ahead?
After a downbeat fourth quarter, China's economy is showing some
signs of life. Manufacturing has rebounded, PMI surveys have
bounced, credit is expanding and auto and home sales show signs of
life. However, exports continue to plummet and lower export
revenues will result in a slowing of reserve accumulation.
Inflation has fallen sharply, permitting rate cuts and a
significant fiscal stimulus by the government. Analysts expect GDP
to grow at around 5 percent in 2009. Given recent data, growth
could even be higher, whereas the earlier perception was that if
anything, growth would undershoot expectations. The jury is still
out as to whether a true recovery can be sustained without a
healthy rebound in exports. The risk is that recent signs of life
are temporary, fueled by a boost in confidence caused by upbeat
official statements. If that proves to be the case, the economy
could slow again in Q2 or Q3, followed by a more sustainable
recovery in 2010.

Despite the uncertainty, China is in an enviable position compared
to most major economies. Growth remains robust even now, consumer
savings are high and consumer and government debt are low. Even
though the growth in reserves has slowed, China has plenty of
ammunition to combat an additional slowdown. If anything, the risk
is that China will divert resources towards the domestic economy by
drawing down (or not adding to) external investments. China remains
well positioned to participate in a global recovery and GDP is
expected to grow at 9 percent in 2010.

India: Challenging times ahead
India's growth unexpectedly slowed to 5.3 percent year-on-year in
the last quarter, as agriculture, exports, manufacturing and
capital expenditure all fell. GDP growth would have fallen even
more sharply if not for soaring government spending, which has
driven the federal deficit to over 10 percent of GDP and caused
S&P to downgrade India's sovereign outlook to "negative."

India has actually been helped by falling commodity prices in
recent months. Should commodity prices begin to rise again (as I
expect later this year), the balance of payments situation will
deteriorate further, unless there is a renewed surge in foreign
direct investment. That appears unlikely under current conditions,
as large fiscal and external deficits are an impediment to growth
and the expectation is that after growing at around 6 percent in
this fiscal year, India's growth will match or undershoot that next
year, in sharp contrast to China. The central bank is expected to
cut rates further in 2009 in response to falling inflation and
slowing growth, but that will only cushion the slowdown, not
reverse it.

What are markets pricing in?
From the beginning of the year until last Friday, China's stock
market is up over 16 percent in both local currency and dollar
terms, as the CNY is virtually unchanged against the dollar. The
consensus forecast is for the CNY to remain almost unchanged in
2009 and appreciate by just over 4 percent between now and the end
of 2010 (Source: Bloomberg Page FXFC). India's stock market is down
by just under 10 percent in 2009 in local currency terms and with
the currency having lost over 5 percent vs. the dollar, the
adjusted equity return is down over 14 percent. The consensus
forecast for the INR is 48 by the end of 2009 and 45 by the end of
2010 (Source: Bloomberg Page FXFC), which equates to an
appreciation of 6.8 percent and 12.6 percent respectively from
current levels.

In other words, the equity market is anticipating a recovery in
China, not in India, while the foreign exchange market expects the
INR to outperform the CNY in gains vs. the dollar. I do expect the
CNY to stay close to current levels for most of this year and
believe it will appreciate by 5 to 6 percent in 2010 - slightly
ahead of consensus. I am a lot less constructive on the INR; I
expect it to end 2009 at 52, slightly weaker than it is now, and
end 2010 at 50, an appreciation of less than 3 percent, compared to
the consensus of 12.6 percent. India's current situation and
prospects are far less favorable and market forces will work to
weaken the INR, with the implicit blessing of the central bank.

The Chinese use two brush strokes to write the word 'crisis.'One brush stroke stands for danger; the other for opportunity. In acrisis, be aware of the danger - but recognize the opportunity.

-John F. Kennedy

The BRIC nations (Brazil, Russia, India and China) are someof the largest emerging market economies and many are hoping thatthis group will lead the global economy out of the worst growthslowdown in seventy years. Russia has had a tumultuous few months.The economy and the currency have tumbled as falling oil prices,outflows of foreign investment, dramatic economic contraction inCentral and Eastern Europe and growing concerns about Russianaggression have taken their toll. Brazil's situation is not quiteas dramatic, but both the currency and the economy have beenimpacted by the global slowdown and falling commodity prices, andthe economy looks set to contract in 2009. The central bank cutrates by a record amount last week in an effort to boost theeconomy.

There is more optimism about the economic prospects for India andChina, partly from a belief that Asia is the region best positionedfor a recovery and that a rising tide will lift the economicprospects...Read More